Oil and gas producers in Alberta can move ahead on drilling and investment plans for 2017 with new technical formulas now available.
These formulas are part of the next step in implementing Alberta’s Modernized Royalty Framework and will determine royalty rates and certain cost allowances. This milestone is another step towards implementing the recommendations from the Royalty Review Advisory Panel.
This announcement delivers on key recommendations of the panel to:
- set out a structure to encourage the reduction of costs in the industry, which will increase net revenues shared by Albertans and industry in all price environments;
- establish new royalty rates on oil and gas wells that preserve existing rates of return at the outset;
- harmonize allowable drilling costs on oil and gas wells to remove barriers to investment; and
- incorporate existing incentive programs and ensure they operate appropriately in both low and high price environments.
“From the day we launched the royalty review, our government has said it will be thoughtful, collaborative and that there will be no surprises. We have worked with industry associations, and I’m confident these formulas will meet the recommendations of the review panel, and create the right system for industry to remain competitive, grow and create jobs.”
“I commend the Alberta government for its timely approach to create a more modern royalty system through a constructive process. This has led to a royalty system that is true to the principles of the royalty advisory report. The new royalty system helps provide more clarity that investors need to plan for the future.”
“The Explorers and Producers Association of Canada is pleased that the conclusion of this royalty calibration process will allow investors and oil and gas producers to move forward with a clear understanding of the new royalty and fiscal terms. The well-run process allowed the thorough exchange of analysis and information between government and industry. The result is a modernized royalty framework, with more transparency and better suited to support investment and development of Alberta’s future energy resource opportunities.”
The new royalty system will reward producers who innovate to reduce costs below the industry average and increase production. Over time, the effect of the change will be to grow net revenues industry-wide, which in turn will make Alberta’s energy sector more attractive for investment, help create more jobs and increase total royalty revenues to the province.
Modernized Royalty Framework
There are three primary elements to the calculation of royalty payments from a well.
The Drilling and Completion Cost Allowance (identified as the C* value in the chart), is used for all resources. It determines at what point a well moves from a flat five per cent royalty rate to a price sensitive rate. The C* value is calculated using industry-wide averages for various factors involved in drilling operations.
There are price sensitive royalty rates for various commodities. They apply over most of the life of a successful and productive well. As wells decline in production, a maturity rate applies. This recognizes higher unit costs and is aimed at minimizing the premature shutting in of production.
The full technical elements of each formula are available online at www.energy.alberta.ca.
How the Modernized Royalty Framework will work in practice
- A company drills a well.
- The well’s true vertical depth, total lateral depth and the amount of drilling or fracturing material (commonly called ‘proppant placed’ in industry terms) used will be entered into the Drilling and Completion Cost Allowance formula to determine C* value for the well.
- Revenue from the well will be tracked monthly by multiplying production volumes of the extracted oil or gas by their respective commodity par prices, as published by Alberta Energy.
- The company will pay a flat royalty of five per cent on early production up until well revenue equals the C* value.
- Afterwards, the company will pay royalty rates ranging from five per cent to 40 per cent (dependent on price) on all subsequent production.
- When resource production from the well drops below a certain rate, called the Maturity Threshold, royalty rates will be adjusted downward to reflect declining production rates and accommodate the mature economics of low productivity, much as they are under the current system.
Government also continues to work on further implementation details and two additional strategic programs that were recommended by the Royalty Review Advisory Panel.
Further details on these programs will be released by May 31.
The new C* and royalty formulas will apply to non-oil sands wells drilled on or after January 1, 2017. Wells drilled before this date will be remain under the old system until January 1, 2027. Details on application to oil sands wells are expected to be released by May 31.
Illustration of the Modernized Royalty Framework